“ and non-resource economic growth: Evidence from Azerbaijan”

AUTHORS İlgar Seyfullayev https://orcid.org/0000-0002-3597-8565

İlgar Seyfullayev (2020). Protectionism and non-resource economic growth: ARTICLE INFO Evidence from Azerbaijan. Problems and Perspectives in , 18(4), 121-129. doi:10.21511/ppm.18(4).2020.11

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businessperspectives.org Problems and Perspectives in Management, Volume 18, Issue 4, 2020

Ilgar Seyfullayev (Azerbaijan) Protectionism and BUSINESS PERSPECTIVES non-resource economic LLC “СPС “Business Perspectives” Hryhorii Skovoroda lane, 10, growth: Evidence Sumy, 40022, Ukraine www.businessperspectives.org from Azerbaijan

Abstract In the modern world, many developing countries take protective measures to develop domestic industries and diversify their economies to ensure economic sustainability. This issue is a priority, especially in those countries where economic development is provided mainly through the of natural resources. This article aims to assess the impact of protectionist measures on the development of non-resource sectors of the economy. The object of the study is the non-oil sector of the Azerbaijani economy, where oil revenues account for over 80% of the country’s total . The study cov- ers the 2005–2019 years. Granger Causality test in the VAR environment was used to identify and assess the causal relationship between protectionist measures and the Received on: 26th of August, 2020 non-oil sector development. It was revealed that such indicators as “customs revenues” Accepted on: 6th of November, 2020 and “exchange rate” do not increase non-oil GDP. The study results suggest that in- Published on: 23rd of November, 2020 creasing the effectiveness of protectionism (in terms of economic growth) requires more reasonable and consistent regulatory measures. Targeting priority sectors and © Ilgar Seyfullayev, 2020 establishing monitoring mechanisms on the results of protectionist measures is also a priority for assessing their feasibility. Keywords economic development, quality of economic regulation, Ilgar Seyfullayev, Ph.D., Associate policy, Azerbaijan Professor, International Magistrate and Doctorate Center, Economics and JEL Classification O24, F63 Management Department, Azerbaijan State University of Economics (UNEC); Economics Department, Azerbaijan INTRODUCTION Technical University, Baku, Azerbaijan.

Today, one of the surprising facts is that Hornik’s rules (Reinert, 2011, pp. 346-349), which appeared at the end of the 17th century, seem to be an attractive approach for developing national economies, especial- ly in developing countries.

The issues of the effectiveness of protectionism from the point of view of the local production development are of particular relevance for countries rich in natural resources, in which institutions are still in their primary stages of development. It is no secret that many developing countries often resort to temporary protective measures fo domestic production to ensure economic security, but not all of them manage to achieve the desired results. And here, questions arise before the theory: What tools for protecting the internal market are more ef- fective? What factors influence the effectiveness of protectionist meas- ures? What conditions are required to achieve the desired results? This is an Open Access article, distributed under the terms of the This article is intended to highlight the effectiveness of protectionist in- Creative Commons Attribution 4.0 International license, which permits struments. In this regard, the assessment of the impact of such protec- unrestricted re-use, distribution, and tive instruments as customs tariffs and the exchange rate on the devel- reproduction in any medium, provided the original work is properly cited. opment of non-resource sectors of the economy was taken as the goal Conflict of interest statement: of the study. The economy of Azerbaijan with formative market insti- Author(s) reported no conflict of interest tutions and rich in natural resources is chosen as the object of research.

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The development of market and state institutions of Azerbaijan has been going on for almost 30 years. A private sector has formed in the country, whose share in GDP reached 85% in 2019 (SSCRA, 2020b). At the same time, government agencies have acquired extensive experience in regulating the economy. The oil boom that began in 2004 had a very strong impact on the country’s economic development and led to a significant increase in its positive foreign trade balance.

However, the oil boom has brought with it a strong dependence of the Azerbaijani economy on oil revenues. Despite numerous government support measures, the bulk of domestic demand for manu- facturing products is met by imports. The domestic industry, once supplying more than 30 countries of the world with mining equipment, metallurgy products, household appliances, textiles, and processed agricultural products, is now in crisis. The weakening of industrial potential led to a radical change in the structure of the economy. The number of employees in the manufacturing industry in 2019 de- creased by 37% compared to 1990. Today, the bulk of the country’s labor force is employed in sectors with diminishing returns (in the agricultural sector (36%), in construction (7.4%), in trade and trans- port (18.6%), etc.) (SSCRA, 2020a).

The above facts also show the practical significance of the results of the studies devoted to the analysis of the protectionism effects.

1. LITERATURE REVIEW O’Rourke and Taylor (2006), using the Rogowski model and the three-factor model, investigated There is an opinion in modern economic theories the effects of the level of democracy in 35 coun- that trade policy and quality of economic manage- tries (developed and developing) on trade open- ment have a huge impact on the economic devel- ness. The results showed that the influence of de- opment of a country. mocracy on the degree of trade openness could be multidirectional: if employees benefit from the Bown and Crowley (2014) using the negative bi- open economy, they will support free trade; if em- nomial distribution (based on explanatory vari- ployees take advantage of trade restrictions, they ables such as real GDP growth, changes in bilat- will support protectionism. If one considers the eral exchange rates, real GDP growth in partner benefits from the trade policy of the state change countries, changes in the unemployment rate, depending on the conjuncture of world markets, growth in bilateral imports (1995–2010)) investi- then one can argue that these benefits are su- gated changes in trade policies of 13 WTO mem- per-dynamic and relative. bers (Argentina, Brazil, China, Colombia, India, Indonesia, Malaysia, Mexico, Peru, Philippines, Abboushi (2010), based on a literature review South Africa, Thailand, Turkey) during macroe- (published in 1967–2018) and the results of empir- conomic shocks. They found that import restric- ical studies, as well as based on a descriptive statis- tions in these countries are countercyclical and tical analysis of data from international organiza- that trade policies of these countries become more tions, concluded that protectionism serves the in- sensitive over time to sharp fluctuations in the real terest of certain groups of the population and does exchange rate. not support social welfare. Protective measures by governments that are in line with the interests Aggarwal and Evenett (2013) argue that after the of internal political groups lead to large losses for 2008 financial crisis, protectionist tendencies in- other segments of the population. creased in global trade, and regional trade agree- ments became more preferred. The growing role Mayda and Rodrik (2001), using the ordered log- of China (where government intervention in it model and the results of surveys conducted in trade is still significant) in more than 20 countries, determined a close cor- has prompted many countries to revise their relation between the development of human cap- trade policies. ital and the support of free trade. They found that

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people working in non-tradable sectors support tries of the world. The study showed that the de- free trade, while employees in those sectors of the gree of a country’s economic development does not economy that engage in international trade based play a decisive role in applying trade restrictions. on comparative advantage prefer import restric- They suggest that as institutions improve, protec- tions. Relative economic status, moral values, and tionist tendencies diminish. Another interesting mentality also affect people’s attitudes toward an finding of this study is that as trade increases, a open economy. country’s propensity to protect itself increases.

Barber et al. (2004) calculated the losses of devel- Kinzius et al. (2019) argue that the number of oping countries from import restrictions on tex- non-tariff trade barriers is growing in the modern tiles and apparel applied in North America and world, and these restrictions lead to a 12% reduc- the European Union at 27 million jobs and USD tion in imports. 40 billion in annual exports. They suggest that de- veloped countries can provide tremendous sup- Park (2018) notes that since 2016, the US has seen a port for reducing global poverty by reducing im- transition from “free trade” to “fair trade” (which port restrictions. is the basis of high tariff barriers and the revision of trade agreements). He argues that the applica- Grundke and Moser (2019) collected the data on tion of high tariffs will lead to higher consumer 93 groups of goods imported from 2002 to 2014 and export prices in the United States, which is from 167 countries in the USA and, with the help fraught with large losses for the economy. In his of the Arellano-Bond GMM estimator, revealed opinion, protectionism is a double-edged sword, that non-tariff restrictions on imports negatively even for the US economy. Such a policy will lead to affect US exports. They argue that there is latent large losses for Northeast Asia economies, which countercyclical protectionism in the United States are more dependent on export volumes. and that non-tariff barriers have intensified dur- ing the crisis years. Panagariya (2004) examined the practice of those countries that have experienced a decline in GDP Costa et al. (2019) examined the effects of a de- per capita in the past 40 years and concluded that preciation of the pound sterling on trade, wag- the economic crisis in these countries is not as- es, and company training costs in the UK. They sociated with an increase in imports. He found a found that in sectors where intermediate import parallelism between the rapid growth and devel- prices increased, the pound sterling decline re- opment of trade (with declining trade barriers) sulted in lower wages and lower training costs for and showed the inconsistency of the idea that free employees. trade leads to income loss.

Alege and Osabuohien (2015), based on data from Egoro and Daddy (2017), using multiple regres- 40 African countries for the period 1980–2008 sion estimation, estimated the dependence of GDP and using a partial-equilibrium relative price ap- on non-oil imports, oil imports, non-oil exports, proach, compiled equations for the dependence and oil exports in Nigeria (1981–2015). They found of exports and imports on the exchange rate, re- that international trade significantly affected eco- al GDP, capital, and technology. Using the panel nomic growth and indicated the need for export cointegration test, they found that the volume of diversification. exports and imports is not elastic concerning the exchange rate. Seipati and Itumeleng (2014), using VECM, in- vestigated the relationships between such indi- Osabuohien et al. (2018), using the logistic regres- cators as GDP, inflation, exchange rate, exports, sion model, investigated the relationships between and imports in South Africa (1990–2013). The propensities for protectionism and indicators such results of the study show that there is cointegra- as economic growth, infrastructure development, tion between all variables and, except imports, economic openness (the ratio of net exports to all indicators have a positive effect on economic GDP), and the quality of institutions in 107 coun- growth.

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Keho (2017), using Toda-Yamamoto and Granger (CR) and “exchange rate” (ER – AZN per unit causality tests and ARDL, studied the Ivory Coast of USD) were taken as indicators characteriz- data for the period 1965–2014 and concluded that ing protectionist measures. Unfortunately, it the trade openness in both the long-term and was impossible to find available information the short-term has a positive effect on economic on anti-dumping, compensating, and non-tar- growth. Besides, he determined that there is a pos- iff barriers. Therefore, the structure of customs itive relationship between economic openness and revenues includes budget revenues from import capital accumulation. taxes (VAT, excise, and road tax) and revenues from customs import duties. The theoretical Benita (2019) investigated the relationship be- rationale for this choice is that customs tariffs tween trade openness and GDP per capita in Latin and taxes are both fiscal and regulatory. The lit- America. He showed that if the model uses data erature review showed that the exchange rate is on mutual trade only between Latin American also widely used as a protection tool. Therefore, countries, then there is a weak but positive im- the exchange rate is included in the model as the pact of economic openness on economic growth. second explanatory variable. However, when data covering all trading partners are included in the model, these relationships are The time series uses monthly data on the NGDP reversed. of the non-oil sector and customs revenues in USD. The inclusion of variables in the model in Ng and Yeats (1999), based on an analysis of the dollar terms allows us to ensure comparability of index of the integration rate of African countries results and somewhat reduce inflationary influ- (below the Sahara) into the , inves- ences caused by changes in the national curren- tigated the impact of trade policy on the economic cy exchange rate. Primary data on NGDP of the development of a country. Using the cross-coun- non-oil sector and at the exchange rate are taken try regression method, they concluded that those from statistics of the Central Bank of Azerbaijan countries that apply good governance and softer (CBAR, 2020), and data on customs revenues trade policies achieve better economic results. are taken from statistics of the State Statistical Committee of the Republic of Azerbaijan Zaman et al. (2018), using fixed effect and pooled (SSCRA, 2020 b). OLS techniques, investigated the relationship be- tween trade openness and FDI inflows in India, The Granger causality test in the VAR environ- Iran, and Pakistan based on data spanning 1982– ment (Granger & Newbold, 1986) was selected to 2012. It was found that there is a statistically sig- identify causal relationships between the model nificant and positive influence between these indi- variables. The quality of relationships and pre- cators. Another finding of the study was that the dictions explanations in time series depends on exchange rate, inflation, and GDP per capita also the correct postulation of the VAR model and influence foreign investment inflows. estimation of its parameters. This study exam- ines whether customs revenue and exchange rate Lewis and Monarch (2016), Gallagher (2012), growth are the reason for the non-oil economic Carstens (2018), Constantinescu et al. (2015), Ojo growth. The Granger causality test in the VAR and Alege (2014), IRC (2016), and others have environment is performed in the following se- shown that protectionist trends play an important quence (Lütkepohl, 2005): role in slowing down the world trade. • stationarity assessment of time series for non- 2. oil GDP, custom revenue, and exchange rate; DATA AND • lag selection; METHODOLOGY • Johansen сointegration test: • construction VAR model; GDP in US dollars for Azerbaijan’s non-oil • assessment of the model quality; economy (NGDP) is considered an indicator of • Granger causality test (Granger, 1969; Granger his sector’s development. “Customs revenues” & Newbold, 1986).

124 http://dx.doi.org/10.21511/ppm.18(4).2020.11 Problems and Perspectives in Management, Volume 18, Issue 4, 2020 3. RESULTS The test results confirm that there is no autocor- relation in the model residuals at the 5% level of Augmented Dickey-Fuller – ADF method (Dickey statistical significance. & Fuller, 1981) was used to determine the station- arity of time series. The results showed that all The results of the VAR Granger causality test are three variables are non-stationary at level but sta- shown in Table 3. tionary at the first difference. Lag 2 was selected Table 3. The results of the Granger causality test based on the minimum values of the Akaike info criterion. Dependent variable: D(NGDP) Excluded Chi-sq Df Prob. These results allowed us to apply the Johansen D(CR) 2.245847 2 0.3253 cointegration test (Johansen, 1988). D(ER) 2.871253 2 0.2380 All 6.153950 4 0.1879 Таble 1. Johansen cointegration rank test (maximum Eigenvalue) The results from Table 3 show that the growth of 0.05 customs revenues and the exchange rate (USD in Hypothesized Max Eigen Eigenvalue critical Prob. No. of CE(s) statistic AZN) are not the cause of the non-oil economy value growth. None * 0.070884 12.42512 21.13162 0.5063 At most 1 0.035207 6.057281 14.26460 0.6059 At most 2 0.000189 0.031950 3.841466 0.8581 These results are also indirectly confirmed by comparing the foreign trade surplus and income from oil exports. The results from Table 1 show that there are no cointegration relationships between the variables As one can see from Figure 1, in the period un- in the model. Therefore, the unrestricted VAR der study, the country’s foreign trade surplus line model was adopted as the method for the evalua- was always below oil exports, and they move in tion of causality relationships. an almost parallel manner. This fact confirms the strong dependence of the country’s foreign trade Table 2 shows the test results for checking the ex- surplus on oil revenues. In recent years, the in- istence of autocorrelation in the model residuals. crease in oil market volatility and the strengthen- ing of downward trends in oil prices have led to a Table 2. Autocorrelation in the residuals sharp decline in the trade balance, which increas- Lags LM stat Prob. es the pressure on the national currency. 1 8.528634 0.4819 2 16.45233 0.0580 For the development non-oil sector in the Republic, 3 13.11577 0.1574 numerous state programs have been developed

Source: CBAR (2020). 12 000 10 000 8 000 6 000 4 000 2 000 0 -2 000 foregn trade surplus oil export Figure 1. Dynamics of Azerbaijan’s quarterly foreign trade surplus and oil exports (2000–2019, in USD million)

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Source: CBAR (2020). 3 000 2 500 2 000 1 500 1 000 500 0 non-oil export non-oil import

Figure 2. Dynamics of quarterly non-oil export and non-oil import in Azerbaijan (2000–2019, in USD million)

and implemented. However, statistics show that Mukhtarov et al. (2019) found that bank loans and the import substitution and export potential of the exchange rate in the long-run have a positive the non-oil sector has not yet reached the desired and statistically significant impact on the develop- level. Figure 2 shows the dynamics of quarterly ment of the non-oil sector in Azerbaijan. non-oil export and non-oil import in 2000–2019. Mukhtarov et al. (2020) showed that oil prices in Facts such as the trade deficit in the non-oil econ- Azerbaijan positively affect economic growth, ex- omy, the persistence of this trend over the past ports, and inflation but negatively reflected in the 15 years, and the satisfaction of growing domes- exchange rate. tic demand mainly due to imports in the non-oil economy show that there are unresolved problems Humbatova et al. (2019) investigated the depend- on the non-oil economy growth in Azerbaijan. ence of GDP, NDP, CPI, exchange rate, and oth- Various studies have been carried out to investi- er macroeconomic indicators on oil prices, iden- gate these problems. tifying complex regression relationships between them in Azerbaijan. 4. DICSCUSSION Dehning et al. (2016) assessed the impact of gov- ernment spending in Azerbaijan before and after Hasanov et al. (2018) found that the non-oil sector the oil boom and concluded that the impact of of the Azerbaijani economy has a weak but pos- budget spending before the oil boom was positive itive response to fiscal measures in the long and and statistically significant, and after the oil boom, short term. They recommend improving the fiscal this influence significantly weakened. environment and saving those government spend- ing that has a weak impact on the development of A comparison of the results obtained allows the non-oil sector. us to conclude that protectionist measures in Azerbaijan have not yet yielded the desired result. Aliyev et al. (2016) show that government spend- The reason for this situation may be the following: ing in the long-run has a positive effect on the non-oil sector, but tax revenues to the budget limit • regulatory measures do not have sufficient this positive impact. purposefulness and precise targeting;

Aliyev and Mikailov (2016) studied the impact of • shortcomings in the consistency of protec- different types of government spending on the tive and supporting measures in the non-oil non-oil sector, found that capital and other spend- economy; ing have a negative, and social spending has a pos- itive and statistically significant impact on the • lack of a clear mechanism for monitoring the growth of the non-oil economy. results of regulation.

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CONCLUSION

The study showed that customs revenues and exchange rates (depreciation of AZN against USD) has not a positive effect on the growth of Azerbaijan’s non-oil economy. And the absence of such influence al- lows us to draw two conclusions: the influence of protective easuresm is not yet sufficient or adequate for domestic production development; Azerbaijan’s non-oil sector of the economy does not yet have suffi- cient potential for an appropriate and quick response. In this context, one can argue that customs tariffs and taxes in Azerbaijan are more fiscal than regulatory. Azerbaijan’s currency policy is more effective in ensuring macroeconomic stability.

The article is the first attempt to assess the impact of customs revenue and the changeex rate on devel- oping the Azerbaijani non-oil economy.

On the other hand, studies of certain non-resource sector reactions to government protective measures could shed more light on the effectiveness problems of protectionism as a tool to support domestic pro- duction. Such studies can also provide new ideas for improving the targeting, consistency, effectiveness, and efficiency of protective government regulations. Furthermore, studies assessing the level of inter- nal competition, linking supportive and protective measures to productivity gains, targeted education, transparency, and focus in public procurement (including in state-owned enterprises) may reveal deeper reasons for the low effectiveness of supportive measures. AUTHOR CONTRIBUTIONS

Conceptualization: Ilgar Seyfullayev. Data curation: Ilgar Seyfullayev. Formal analysis: Ilgar Seyfullayev. Funding acquisition: Ilgar Seyfullayev. Investigation: Ilgar Seyfullayev. Methodology: Ilgar Seyfullayev. Project administration: Ilgar Seyfullayev. Resources: Ilgar Seyfullayev. Software: Ilgar Seyfullayev. Supervision: Ilgar Seyfullayev. Validation: Ilgar Seyfullayev. Visualization: Ilgar Seyfullayev. Writing – original draft: Ilgar Seyfullayev. Writing – review & editing: Ilgar Seyfullayev. REFERENCES

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